Net zero and the banking sector

The world will have to work much harder to meet its climate goals. That is the tough conclusion of a recent report from the secretariat of the United Nations Framework Convention on Climate Change, which finds that national climate action plans remain inadequate to keep global warming to the maximum of 1.5C above pre-industrial levels set out in the 2015 Paris Agreement. The banking sector has a critical role to play in helping companies and individuals achieve targets for net zero greenhouse gas emissions, in most cases by 2050.

Says UN Climate Change executive secretary Simon Stiell: “Governments combined are taking baby steps to avert the climate crisis. [They] must not only agree what stronger climate actions will be taken, but also start showing how to deliver them.”

At a time when many governments are increasingly concerned about the cost to their citizens of embracing net zero, Stiell says it is urgent to make the alternative case: “It’s time to show the massive benefits now of bolder climate action: more jobs, higher wages, economic growth, opportunity and stability, less pollution and better health.” The rewards can be significant, but companies need to be incentivised to achieve them.

It’s time to show the massive benefits now of bolder climate action.

In general, the intentions are in place – 140 countries have a net zero target, covering 88% of global emissions – but the problem lies with implementation. The UN says more than 9,000 companies, 1,000 cities, 1,000 educational institutions and 600 financial institutions have joined its Race to Zero, a global campaign to rally leadership and support for pledges of immediate action to halve global emissions by 2030. Luxembourg is committed to net zero targets through the EU.

The role of banks

Banks are in a unique position. They need to work on both their own carbon footprint, ensuring that they use natural resources prudently in their day-to-day operations (as well as being responsible in the way they treat staff, as part of broader sustainability commitments). However, they also have a powerful influence through their approach to lending and investment – the source of the majority of the emissions related to banks, and where they can effect the greatest change.

It is also a risk management consideration for institutions. Regulation is in a constant state of evolution – businesses that do not address their environmental footprint – at least in terms of transparency about their impact – could in the future face fines and other penalties. The adoption of carbon taxes, which require companies to pay a levy based on their emissions, is growing worldwide. There are also reputational considerations: increasingly shareholders expect companies to manage their environmental risks effectively, while employees and customers may favour groups that are making demonstrable progress toward reducing their emissions.

The EU’s Corporate Sustainability Reporting Directive will expand, eventually to an estimated 50,000, the number of companies that will be required to make environmental disclosures, and increase the level of detail they must provide, starting in 2025 and progressively increasing up to 2029. This is vital for the banking sector and other members of the financial industry, making it easier for them to measure the emissions impact of their lending and investment decisions.

Emissions reporting is governed by international standards. The Greenhouse Gas Protocol, first launched by the World Resources Institute and the World Business Council for Sustainable Development, sets out three categories of greenhouse gas emissions:

• • scope 1, emissions generated by a company’s own business activities;
  • scope 2, covering indirect emissions from purchased energy;
  • and scope 3, emissions from the value chain, such as those generated by suppliers, as well as the use of its products and services by customers.

For banks, scope 3 emissions – those generated by companies to which they lend and facilitate investment – are the most significant.

If providers of finance refuse to engage with companies, depriving them of the capital they would need to change their business model, they may lack both the incentive and the means to do so.

Embracing the transition

The easy option for banks would be not to lend to companies with high carbon emissions, but this entails significant risks to the goals of the climate transition. If providers of finance refuse to engage with companies, depriving them of the capital they would need to change their business model, they may lack both the incentive and the means to do so. High-emission companies may instead seek out other providers of financing that are less concerned with sustainability goals.

Alessandra Simonelli, Head of Sustainable Development at Banque Internationale à Luxembourg, says: “Some institutions say they won’t lend to companies in high-emitting sectors, but this doesn’t solve the problem – it doesn’t help reduce overall emissions. Many companies need investment to make the necessary transition. The automobile industry, for example, is moving from combustion engine cars to electric vehicles. All companies need to invest to change their business models to contribute to the overall transition.

Instead, our role is to discuss how we can support them in their transition, challenge them and compare them. Our role will be to assess ESG performance and transition plans. If we see they are not doing what they promise, we might rethink our attitude toward future support.”

Alessandra Simonelli also points out that whenever the bank provides financing to a business, it notes the volume of the recipient company’s greenhouse gas emissions that are related to the financing, and uses it to calculate BIL’s own emissions.

The situation isn’t perfect. Many companies are not yet reporting in full and will not be legally obliged to do so for several years yet. Even in Europe, the region of the world where climate transparency legislation is most advanced, it will be difficult to see year-by-year progress until the reporting parameters are better established. However, some companies are leading the charge by embracing voluntary initiatives, and industry initiatives such as the Net Zero Banking Alliance are seeking to assist in setting standards and best practice for the sector.

Helping individuals go green

Achieving net zero is not just about lending to companies – banks must also consider their relationships with individual customers. So-called green mortgage lending and other types of loan are becoming more widespread, to buy energy-efficient homes or make existing ones more sustainable. Banks have an interest in encouraging clients to improve their energy efficiency to boost the value and attractiveness of the asset against which they are lending. The risk is the introduction of new legislation that makes it more difficult to sell homes where these changes haven’t been made – or bars owners from renting out their property.

Another important element is where a bank invests its own capital directly. Alessandra Simonelli says BIL aims to play a role in financing companies that are providing solutions to mitigate climate change. She says: “Making sure we make the right investments is an important part of what we do. We want to support companies that are really making a difference on environmental management.”

The banking sector has a vital role to play in encouraging companies and individuals to reduce their carbon footprint, and the EU’s forthcoming corporate disclosure rules will soon start to provide more information to help them perform that role more effectively. The pivotal role of banks in lending and investment promises to have a significant impact on progress toward achieving net zero targets.

Refusing to lend to companies in high-emitting sectors doesn’t help to reduce overall emissions – many companies need investment to embrace the climate transition.